Skeptics of the Austrian narrative of the Great Recession – that inflation caused malinvestment bubbles, particularly in the housing sector, which eventually burst – often point to the lack of empirical evidence for this thesis. David Andolfatto seems to offer some of this vital empirical evidence (hat tip to Arnold Kling):

The collapse of the construction sector accounts for 46.4% of the decline in U.S. GDP and 51.9% of the decline in total employment (roughly 3.4 million jobs).

That’s important, because – if it’s true – it really would suggest, empirically, that the Austrian story about the crisis is the right one. You probably know the narrative by now – easy money distorted relative prices, making construction appear to be more in demand than it really was, causing a lot of people to invest too much money and time building things that nobody ended up wanting. Once prices started to stabilize and reflect real demand, a lot of the people who’d made bad investments need to cut their losses and get rid of them. The same goes for people who’ve trained in skills that aren’t really needed – they’ve got to retrain now that reality has bitten.

Andolfatto’s analysis is interesting, because it attempts to model the shockwaves that a change in a large single sector can have on the rest of the economy. If you’ve set up a business selling coffee to workers at a now-defunct construction site, you’re out of business. If some of your customers were construction workers, whatever your business, you’ll be making less money now, and so will the people who you bought money from. And so on. The interconnectedness of the economy is sometimes difficult to grasp, but it’s really important to understanding why one sector going *pop* can affect so many other sectors so badly. 

The policy implications of this perspective are quite signficant. Forget trying to "stimulate" your way out of a recession through spending or printing money – all you’ll be doing is creating another type of false, unsustainable demand. You’ll do the most damage if the stimulus is aimed at the unemployed, the people who need to retrain to cope with the real economy the most: reskilling takes time, and will be put off if there’s some public works project nearby that will hire you instead. Even taking up unemployed people’s time has an opportunity cost; justification for "stimulus" programmes ignore this.

Stimulus and government spending aren’t just bad because they cost money; they’re bad because the people they employ could be doing something else with their time that people actually want. That’s the crucial thing that many economists ignore – time. A recession takes time for people to resolve their difficulties. Impatient governments can’t do anything to speed that along, except get out of the way.

6988
blog/tax-and-economy/the-case-for-recalculation